Channeling trends in stocks

One of the simplest applications of the CCI is a zero-line crossover. As the CCI generally varies within the +100 to –100 range, any move above +100 or below –100 shows an unexceptional strength or weakness that can extend itself further. The zero-line is precisely in the middle of these extremes. Traders use the zero-line cross as a potential entry point under the assumption that trend bias has shifted from negative to positive, or vice versa, and is headed toward one of the extremes.

A word of caution, however. Actively trading on every zero-line crossover can result in numerous whipsaws, particularly if the stock is currently range bound. As long as we are prepared to accept that risk, the following are some basic, unfiltered trade rules for a zero-line crossover:

Buy when the CCI crosses its zero-line from below, setting a stop loss at the previous day’s low. If the market runs higher as expected, profit should be booked once price gives back enough of the new uptrend to break the three-day low.

Sell when the CCI crosses its zero-line from above, setting a stop loss at the previous day’s high. If the market falls as expected, profit should be booked once price gives back enough of the new downtrend to break the three-day high.

“Gold gains” (below) shows the iShares Gold Trust (IAU) exchange-traded fund (ETF) with a 20-day CCI on the daily time frame. On Aug. 15, 2012, IAU closed at $15.62 after making a low of $15.58 with the CCI at –2.72. On Aug. 16, the ETF opened at $15.65 and the CCI moved into positive territory, giving us a signal to initiate the trade with a stop loss of $15.58. The ETF rallied, made a high of $16.31, and the CCI kept moving until it reached 369. As per our exit rule, we took profits on a break of the three-day low, which was triggered Aug. 30 when $16.19 was broken.